Financial and International Accounting Standards Boards - Assignment Example

Revenue Recognition—Joint Project of the FASB and IASB Name: Institution: Revenue Recognition—Joint Project of the FASB and IASB Introduction The project and its History The IASB together with the FASB are conducting a joint project to develop a principle-based standard of revenue recognition. This is aimed at Acknowledging deficiencies in current regulations and aiming at a change in the same. This is of importance given that revenue is crucial to users of financial statements in assessing an entity’s performance and future prospects. As it stands, there are two sets of requirements for revenue recognition; those proposed by generally accepted accounting principles (GAAP) and those in International Financial Reporting Standards (IFRSs) and both sets of requirements are said to be in need of major improvement. GAAP principles comprise of revenue recognition concepts that have numerous requirements for specific industries and transactions. This can potentially result in different accounting procedures for similar transactions. On the other hand, in IFRS, the two main revenue recognition standards, IAS 18 and IAS 11, can be difficult to understand and apply to complex transactions. In this regard, the two boards are aiming at developing a single revenue recognition model that can be applied in different industries and to various transactions. The newproposed revenue recognition model will work in such a way that revenues will be recognized based on changes in assets and liabilities. This means that the Boards seek to focus on the change in an entity’s net position (increase in contract asset or decrease in contract liability) as the main determinants of revenue (Munich Business Research, 2006). The proposed model has a number of objectives which include; removal of inconsistencies and weaknesses in the current revenue recognition practices; it also aims at providing a framework for addressing issues dealing with revenue recognition; in the proposed model, comparability of revenue recognition practices across industries, organisations, transactions, jurisdictions, and capital markets is greatly enhanced; and finally, the model seeks to simplify the preparation of financial statements. Projects History It was in January 2002, when the FASB first discussed the idea of undertaking a major project that would address the recognition of revenues in financial statements (Frank, 2011). The project would also seek to make amendments on existing guidelines related to revenues and liabilities. The main objective of the project would be to come up with a new accounting standard for revenue and liability recognition.It was in June the same year that the IASB decided to work together with the FASB on this project. Initially, the two Boards had decided to develop a revenue recognition model that would apply fair value in measuring assets and liabilities. It was later decided that the fair value approach or model and the customer consideration model should be developed simultaneously. This wasdone by two groups formed from the two boards. From the discussions, the Boards agreed on a single contract-based revenue recognition model in favor of the customer consideration approach of measuring revenue performance obligations. Current Status of the project The project has currently introduced the Exposure Draft whichprovides an overview of the proposals that have so far been developedjointly and unanimously agreedupon by the FASB and the (IASB). The Exposure Draft is as a result of detailed and comprehensive discussions by the Boards (FASB, 2010b). In order to include the views of all stakeholders the Boards have invited all interested parties to give their inputs as part of their rigorous exercisetowards the successful completion of this project. The inputs have been coming in from investors, accountants, auditors and other financial reporting regulators. From thefeedback received from these groups the Boards intend to go back to the table and deliberate on any significant issues that may have been raised from these discussions. At the end of the year the boards are aiming to be done with this rigorous exercise and finally present a final revenue standard. The single comprehensive standard of revenue recognition will seek to address the inconsistencies in the current conceptual guidance of revenue recognition. As at the last meeting held on 19th September, 2011, the Boards held a discussion to enable them to determine whether to postpone the effective date of the proposed revenue recognition standard for nonpublic entities. It was decided that the effective date for the nonpublic entities will be extended by a minimum period of one year following the effective date for public entities of the new guidance for the proposed revenue recognition standard. Previously, The Boards had indicated that the effective date for public entities shall be periods beginning on or after 1st January, 2015. However, there is still a chance that The Boards will reconsider the proposed effective date, as it reevaluatesseveral other aspects of the Exposure Draft, which may be proposed by other stakeholders before issuing a final standard. Implication of the project’s adoption Unlike present IFRSs that apply the traditional realization Principle as a rule of determining income, the proposals of the Revenue Recognition projectrely on a conceptual model which follows an asset-liability approach. In the proposed standard of revenue recognition, there will be more enhanced disclosure requirements in the financial statements. This will help the users of such statements to have an in-depth understanding of the various contracts; amounts; timing, and uncertainty of revenue and cash In the proposed standard of revenue recognition companies will be required to disclose qualitative and quantitative information about contracts with their customers especially those extending beyond one year and also give disclosure on judgments made in applying the standard to customers contracts. Any changes in such judgments must also be disclosed. From the proposed standard, companies will be required to give a full and detailed account for all goods or services. This means that a company can be able to separate a contract into units of accounting unlike those identified in current practice. Unlike in current practice revenue will be recognized on the transfer of goods or services to customers that is, asset-liability approach (Munich Business Research, 2005). This will greatly affect the long term contracts (extending beyond one year) that a company might have at the time of the implementation. Another factor that will be greatly influenced on the adoption of the proposed standard will be revenue. This is because the project proposes that revenue be recognized when it is collected rather than whether revenue has been recognized. In the new proposed standard, there will be a greater need for estimates as they will play a key role in identifying the amount for allocation and the basis of the allocation that will lead to a better understanding of the economics of a company’s transactions. Discussion of the proposed change Existing standards (U.S. GAAP & IFRSs) need improvement to meet users’ requirements. Most Users of financial statements need information about revenue that will allow them to compare performance of companies across entities, industries and capital markets. The current standards contained in US GAAP and IFRSs have many disclosure requirements. These disclosures are an indication of the inadequacies of these standards. For instance, US GAAP consists of many concepts of revenue and has industry-specific requirements for revenue recognition that can lead to different accounting applications for economically similar transactions. On the other hand, although IFRSs contain fewer disclosure requirements, using this standard can be difficult to apply in complex transactions and no guidance is offered on treatment of such items as multiple element arrangements. One of the objectives that the proposed standard has to meet is the elimination of the shortcomings of current standards.Concerning this objective, the FASB has to reconcile Revenue Recognition requirements that are contained in US-GAAP (FASB, 2005b). It has been observed by the ISBA that the current IAS 18 relies heavily on the happening of a critical event and still fails to provideguidance on multi-element contract. However, there still exist some shortcomings within the Framework concerning unclear differentiationbetween revenues and gains and also failure to define profits satisfactorily. In conclusion, both the proposed Framework and the IFRSs lack a firm foundation of the concept of income (Hettich, 2006). There is therefore a need to come up with a standard that mixes the essentials of the asset and liability approach and those of the revenue-expense approach as well as a clear definition of profit and loss. Following these shortcomings of current standards of revenue recognition the proposed changes in the project are aimed at improving financial reporting. This is through the achievement of the projects main objective which is to create a single revenue recognition standard that can be applied consistently across industries and capital markets. This will further clarify the principles of revenue recognition to users’ of financial statements. The key improvements that have been proposed will seek to improve financial reporting in certain areas. These includeremoval of inconsistencies in the existing revenue recognition standards; coming up with a system that allows comparability across industries; and enhancing disclosure policies and finally giving guidelines on accounting for contract costs. Impact on Stakeholders Throughout the process of coming up with the new proposed model of revenue recognition, the Boards have along the way asked for feedback from various stakeholders by use of preliminary view documents. In these documents, the Boards solicit for feedback from interested parties by inviting comments for a certain period of time on a specific matter that they have themselves agreed on. In most cases, the stakeholders in matters of financial reporting standards include industry players like accountants and auditors, users of financial statements like current and potential investors of a firm, government agencies especially for the purposes of taxation, and other regulators that may not be directly involved in making the changes to the standards.For instance in June 19, 2009, the Boards received numerous comment letters in response to the current discussion paper at the time (FASB, 2009c). Amajority of the respondents were in great support of the Boards’ main objective ofdeveloping a singlerevenue recognitionmodel that reconciled the applications of both U. S. GAAP and IFRS (FASB, 2009d). Among the respondents were the Accounting Standards Executive Committee (AcSEC) and the American Instituteof Certified Public Accountants (AICPA) who showed their support for the proposed standard by basing the principle on an entity’s contract assets and liabilities. Among the respondents, there was general agreement in that the single revenueprinciple objective was commendable. However, many comments and questions were floated as to the feasibility of the main objective. The general feeling among these respondents was that the GAAP and the IFRSs standards had been developed to clarify how to recognize revenue for particularindustries and therefore the respondents felt that there was a need to maintain this differentiation. This was despite the fact that maintaining those standards might create inconsistency, as they still provide usefulinformation about the types of contracts for which they were intended for a particular industry. From the comment letters, the Boards acknowledged that there does notexist a great need to replace current requirements but it would be possible toimprove many of the existing requirements without replacing them. The Boards however maintained that though there had been significant changes to U. S. GAAP, the existing revenue recognitionrequirements would still fell short in the sense thatinconsistencies in accounting for revenue would still arise in the future. The Boards also acknowledged that existing requirements for U. S. GAAPand IFRSswould form an important part of developing a single set of high quality global accounting standard of revenue recognition (FASB, 2010b). Finally, the Boards chose to commence with the asset-liability approach and to use it as the model for revenue recognition contained in the Exposure Draft albeit with some minor modifications. The new standard of revenue recognition will have an all-round positive impact on all the stakeholders mentioned above in that decision making will be made significantly easier due to reduction in disclosures and also due to the ability to make inter-transaction, inter-entity, inter-industry and capital market comparisons. References Financial Accounting Standards Board. (2010b). Project Updates: Revenue Recognition, May, 2010. Norwalk, CT: FASB. Financial Accounting Standards Board. (2009c). Staff Paper: Revenue Recognition-Background Information: Putting the October staff papers in context. Norwalk, CT: FASB. Financial Accounting Standards Board. (2009d). Staff Paper: Revenue Recognition-Segmenting a Contract. Norwalk, CT: FASB. FASB. (2005b). Project Updates: Revenue Recognition, 2.12.2005. Frank, E., Ryerson, III, & Macon State College. (2011). Major changes proposed to GAAP for revenue recognition. Journal of Finance and Accountancy. Hettich, S. (2006). ZweckadäquateGewinnermittlungsregeln, Frankfurt am Main. Forthcoming. Michael, D., & Silvia Hettich Munich Business Research. (2005). Rethinking Revenue Recognition. Academic Journal of Finance. Read More